United Natural Foods, Inc. (UNFI) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Chantal, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the United Natural Foods Inc. Second Quarter Fiscal 2019 Results Conference Call. All lines have be placed on mute to prevent any background noise. After the speakers remarks there will a Question-and-Answer session. [Operator Instructions] Steve Bloomquist, VP of Investor Relations, you may begin your conference.

Thanks Chantal, and good afternoon everyone, and thank you for joining us on today’s call. By now you should have received a copy of the earnings release issued this afternoon. The press release, the webcast and the supplemental slide deck are available under the Investors section of our website at www.unfi.com under the events tab. Joining me for today's call are; Steve Spinner, our Chairman and Chief Executive Officer; Sean Griffin, the CEO of SUPERVALU; Mike Zechmeister, our Chief Financial Officer; and Chris Testa, President of UNFI. Steve, Sean and Mike will provide a business update, speak about our performance in the quarter and address our fiscal 2019 outlook. We'll take your questions after management's prepared remarks conclude. Before we begin, I'd like to remind everyone that comments made by management today during the call may contain forward-looking statements. These forward-looking statements include plans, expectations, estimates and projections that might involve significant risks and uncertainties. These risks are discussed in the Company's earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements. And lastly, I'd like to point out that during today's call, management will refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP financial measures are included in the schedule included in our press release. With that, I’ll turn the call over to Steve.

Thank you, Steve. Good evening, everyone, and thank you for joining our second quarter earnings call. I'll start with some comments on the quarter and our fiscal 2019 outlook. Sean will then provide more detail into SUPERVALU’s results including our integration work. Mike will further review our financials and updated outlook. First and foremost, we're progressing rapidly and positively towards integrating legacy SUPERVALU into UNFI. Our strategy to create the most sophisticated and scaled supply chain network for retail is without equal. It is compelling. This is a long term strategy which will take some time to deliver. In the near-term we will face temporary challenges associated with integration and the optimization of our distribution network. While I'm disappointed by the performance at several of our SUPERVALU distribution centers, which was the primary driver of our EBITDA shortfall, we are seeing material improvement in these DC's every day. We have a long history of change management, network improvement and growth. And it's important to keep in mind that at legacy UNFI during the last six years, we've built four new distribution centers. We know how to build an efficient and productive supply chain. Let's start with total company net sales, which increased by more than $3.6 billion in the quarter to $6.1 billion. Legacy UNFI net sales were up 5.8%, which was primarily attributable to the supernatural channel. The macro economic environment continues to be challenging in several of our distribution channels, driven in part by accelerating store closures, slowing new store growth, and the hyper competitive chase for consumers. Despite these near term trends, the demand for better-for-you products remain strong and we should cycle through these short term headwinds. SUPERVALU added nearly $3.5 billion in net sales in-line with our expectations. As I mentioned earlier, SUPERVALUE’s contribution to adjusted EBITDA was not where we want it or frankly expected it to be. We believe we have a good understanding of the underlying issues and have begun taking the appropriate measures to quickly address and correct them. Sean will go into more details from an operational perspective, but one of the most impactful issues was the higher than anticipated expenses for its several distribution center realignment and optimization projects. These challenges are short term in nature and we’re confident we'll fix them. Our financials also reflect a $370 million goodwill impairment charge we took this quarter, which Mike will get into shortly. This charge, was driven primarily by the change in value of UNFI’s stock price since the acquisition was announced. This is a non-cash charge that does not impact our cash flows or business operations. Mike will also address UNFI’s conversion to LIFO legacy UNFI, which negatively impacted Q2 and our anticipated adoption of a 338 tax elections, which will positively impact the Company by over $300 million in cash taxes over the next 15 years. From an earnings per share perspective, we delivered $0.44 in adjusted earnings per share for the quarter, well above our estimates. However, we benefited from lower depreciation and amortization expense relative to our prior guidance. This change is reflected in our increased full year outlook for EPS and adjusted EPS. While the overall results are not what we would like, I am pleased with the progress we're making on bringing UNFI and SUPERVALU together. Let me call out a few noteworthy accomplishments over the last three months. First, our integration work is proceeding largely as planned and we remain comfortable with our cost synergy estimate of more than $185 million in year four. Next month, we'll be expanding the distribution of several of our exclusive label brands into more distribution centers. Wild Harvest, Field Day, Woodstock Farms and Everyday Essentials are in demand by retailers and will derive incremental sales for us. At the same time, we're also in the process of preparing to convert to a single payroll system with a summer go live date and our supply chain teams are completing the initial project plans for several distribution center consolidations including transitioning from five distribution centers in the Pacific Northwest into two locations that we announced last month. All really good for UNFI and really good for our customers. Second, we finalized our new supply chain structure, which set in motion the framework for how the new UNFI will work together. As part of this we've gone from six regions, three each at both UNFI and SUPERVALU to a four region structure. These four regions will encompass all distribution centers as well as our Albert's and Tony's business units. This new structure will facilitate greater collaboration across our network, support the standardization of systems and processes, deliver greater cross selling opportunities and fully leverage our great scale and diversification. Third, our suppliers are embracing what we're doing and recognize that UNFI will be a growth vehicle for them over the short and long term. We've completed over 30 top-to-top supplier meetings and the feedback as we suggested at our investor day continues to be overwhelmingly favorable. And we're winning new business. A long tenured conventional customer service side of our Hopkins, Minnesota Distribution Center recently signed a new supply agreement for natural and organic product where we'll have our Racine Wisconsin distribution center partner with the Hopkins, Minnesota, DC in servicing their stores. Another conventional customer supplied out of our Champaign Illinois DC operates stores in the Chicagoland market including an extensive catering offering. In their new natural organic and specialty supply agreement they've opted for a full service, meaning a dedicated UNFI team will be working exclusively in the stores with this retailer's team managing the process from order to delivery and beyond. At legacy UNFI we’ve talked about adding conventional produce to further enable a truly built out fresh offering to our Albert's business unit. With over 1.5 billion in annual produce sales we are positioned as a national retail focused, fresh distributor able to compete in most markets with the widest range of products available. Our customers want and need to consolidate suppliers in order to reduce costs in their supply chain. Additionally, we are winning services business at legacy UNFI retailers. These include coupon redemption, credit card processing and payroll services. These are great examples of our build out the store cross-selling strategy coming to life and a testament to our field personnel working with these customers to drive their business forward. The last example of our earning new business is the when we had recently of a 10 store retailer who had been with a competing wholesaler for 79 years and we are now proud to welcome them to the UNFI family. The owner cited our offerings services and our people as the key factors in their decision to sign with us. Our sales teams are executing against a healthy pipeline of cross selling opportunities. These include expanded professional services and product portfolios into our newly combined account base in addition to attracting new customers. Let me now turn the call over to Sean for some further insights. Sean.

Thank you Steve and good evening everyone. Tonight I'll cover two topics. The first SUPERVALU’s performance in the second quarter and impact to our updated outlook for the fiscal year as well as some insight into the integration and transition work and the progress that was well underway. So, let's begin with the results at SUPERVALU, which quite frankly were disappointing. Compared to the guidance we gave in December, the adjusted EBITDA from SUPERVALUs wholesale business was significantly short of our expectations in the quarter. The single biggest driver of this shortfall has been meaningfully higher costs related to the disruption, of our distribution center realignment and integration execution at a small number of distribution centers including the two network realignment projects that I discussed at January's Investor Day. And as a reminder specifically the move from Lancaster, Pennsylvania to a new distribution center configuration in Harrisburg and Carlisle PA as well as the consolidation and optimization of distribution centers in the Pacific Northwest. To date, these projects have proved more challenging than we originally anticipated, which has resulted in significantly higher labor, transportation and shrink costs. Now on a positive note, what we've learned from these opportunities, these challenges, if you will, has informed the change and how we go forward and significantly and positively impacted our AG stabilization and standardization event, which occurred as planned in January, this past January. We are seeing improving trends sequentially in these challenged DCs as our national supply chain team is now moving us forward. Relative to our December guidance, we've lowered our rest of the year outlook for SUPERVALU’s wholesale business based on what we experienced in Q2 as well as our plan to accelerate the opening of our new Centralia facility in the Pacific Northwest. Although lower than three months ago we are factoring in continuous sequential improvement for the balance of the year. It is important to note that these operational issues are within our control. Detailed planning followed by a high level of execution by experienced teams is our path forward. We are on a path towards fixing these issues by the end of our fiscal 2019 and as Steve mentioned, we have the right people and the right systems to further enable SUPERVALU’s legacy DC performance. Let me also comment on another initiative that I've undertaken this quarter, which is to take a deeper dive into customer level profitability. Through detailed analysis of our customer base, we are seeing some areas where we believe we can improve our profitability. And we're looking into such areas as by example; Do we have incremental category for item level sales opportunities with an existing customer relationships that will improve our economics as well as show benefits to our customers and exercise not unlike how we're assessing our cross selling opportunities. In essence can we sell more to existing customers? Where we are under penetrated in our service offerings to our customer? How we are reviewing customer orders, order frequency and delivery size and can we deploy incentives that lower customer labor costs, while improving our operational economics? Are there customers in the portfolio that we will need to rationalize if we cannot move up the profitability hurdle through additional purchases of goods services or by increasing our price. Now let me provide some additional insight into the UNFI SUPERVALU integration work. Overall, we're very pleased with the way the two companies are coming together. There is a great deal of hard work being done in much that is being accomplished in a relatively short period of time. I’d like to take a moment to highlight a few. First, we've actioned nearly a 10% reduction in our administrative workforce since we closed on the SUPERVALU acquisition. This is the result of a thorough and detailed bottoms up organizational design and assessment work which has been done and focused on evolving to the structure that we believe to be the most appropriate and effective in supporting our long-term operating model and go to market strategy. I'm also happy to say we've successfully standardized the AG Florida business into SUPERVALU systems last month. This transition was very well planned and very well executed. It creates operating efficiencies for UNFI as well as streamlines many customer facing processes such as ordering, invoicing and reporting. Our indirect procurement team, which focuses on goods and services not for resale, is actively working on 44 projects, which will utilize our newfound scale and a combination of our two companies to lower our company wide cost structure. As an early example, we've negotiated a new service agreement with a single provider of companywide travel in third party staffing. Additionally, we renegotiated several inventory supplier agreements and implemented preferred trade terms across several categories. And finally, I'm most encouraged by the success we're having in capturing new profitable business with both existing customers as well as new customers to our enterprise. Our new business wins, which Steve touched upon amounts to nearly 200 million on an annualized basis. And really we're just getting started and I'll finish by repeating my comment that while Q2 was a disappointment that will have a carryover effect on how we're thinking about the balance of the year, the challenges that we're facing are short term in nature. We can fix them. I'm encouraged by the many positive improvements we're seeing in this business and the opportunity that's ahead of us to create the largest and most sophisticated supply chain and services network for retail grocery throughout the U.S. and Canada. Our teams are highly focused and we're coming together quickly to capture our synergies and execute our strategic vision. With that, I'll turn the call over to Mike.

Thank you Sean, and good evening. I will cover our second quarter performance and updated outlook for fiscal 2019. Let's start with our second quarter results, which now include a full quarter contribution from SUPERVALU. Q2 net sales were $6.15 billion, an increase of approximately $3.62 billion compared to Q2 last year. SUPERVALU accounted for $3.47 billion of the increase while legacy UNFI accounted for the remaining $2.68 billion, which represents comparable year-over-year growth in Q2 of approximately 5.8%. We experienced inflation of 1.26% for the second quarter, which is the highest we've seen in 12 quarters, dating back to second quarter of fiscal 2016. From a channel perspective, legacy SUPERVALU is now included in our reporting. Supermarket channel now represents 63.5% of total net sales, including SUPERVALU’s wholesale net sales of $3.2 billion. Excluding the impact of SUPERVALU, legacy UNFI’s supermarket channel, net sales decreased by approximately 1.4% in Q2. Second quarter Supernatural net sales grew 18.2% over Q2 of last year and represented 17.9% of total net sales compared to 36.8% of total net sales in Q2 last year. Net sales in the independent channel grew 25.3% and represented approximately 13.2% of total net sales. Excluding the impact of SUPERVALU independent channel net sales grew by approximately 4.6%. Lastly, our other channel grew by 44.0% and represented 5.5% of total net sales. Legacy UNFI sales in this channel decreased by 17.4% driven primarily by e-commerce declines where we have yet to cycle sales declines from the less profitable business that we exited last fiscal year. Let's turn to gross margin. Gross margin for the second quarter was 12.39% of net sales and included $8.6 million noncash expense to complete the unwind of the stepped-up basis of SUPERVALU’s inventory, resulting from the purchase accounting that we discussed last quarter. Excluding this expense, gross margin in the second quarter was 12.53% of net sales, a decrease of 217 basis points compared to the same period last year. This decrease was driven by the mix impact of adding SUPERVALU, which operates at a lower gross margin rate, higher levels of shrink at legacy SUPERVALU distribution centers and a shift in customer mix within legacy UNFI including softer sales to non-supernatural channel customers with higher margins. Within legacy UNFI, we also experienced lower year-over-year freight expense which was offset in Q2 by a LIFO charge driven by increased inflammation. Q2 operating expense totaled 12.23% of net sales, 43 basis points favorable to the 12.66% in last year’s second quarter. Legacy UNFI’s operating expenses as a percent of net sales were lower by approximately 54 basis points, primarily driven by the benefit of acquisition synergies. For the quarter, legacy SUPERVALU’s operating expenses as a percent of net sales were approximately 20 basis points higher than legacy UNFI’s. Even though last year's Q2 results did not include SUPERVALU, legacy SUPERVALU’s year-over-year operating costs were higher in Q2 due to the impact of the network realignment projects that Sean discussed as well as additional rent expense from the sale leasebacks completed by legacy SUPERVALU over the past 10 months. In the second quarter, legacy UNFI fuel costs decreased by one basis point as a percent of net sales in comparison to Q2 of fiscal 2018 and represented 44 basis points of distribution net sales. Our diesel fuel cost per gallon increased 3.6% in Q2 versus Q2 last year. And the Department of Energy's national average for diesel fuel was up approximately 6.4% or $0.19 per gallon compared to the same period last year. Share-based compensation expense, which is excluded from adjusted EBITDA, represented 17 basis points of total net sales in Q2 compared to 26 basis points in the second quarter of last year. Operating loss for the second quarter, excluding discontinued operations was $408 million and included several nonrecurring items. First, we recorded a goodwill impairment charge of $370.9 million. I'll elaborate on that in a bit. Second, we recorded restructuring, acquisition and integration-related costs totaling $47.1 million, which includes $19.5 million for lease reserves related to the exit of retail banners. Third was the $8.6 million noncash charge related to unwinding the stepped-up inventory basis at SUPERVALU, which I referenced earlier. Excluding these amounts, operating income was $19 million or 30 basis points as a percent of net sales, compared to $51 million or 2.04% of net sales last year. When excluding the $11.2 million in charges related to exiting the company's Earth Origins Market retail banner. In Q2, the decline was primarily driven by lower gross margins and higher operating expenses related to the DC network realignment that Sean referenced earlier. Adjusted EBITDA for the second quarter was $143 million, an increase of 79% compared to $80 million last year, driven primarily by the addition of SUPERVALU. Net interest expense in Q2 was $58.7 million and included expense of $2.5 million related to the now retired SUPERVALU bonds and the write-off of $1.0 million of unamortized issuance costs related to certain term loan prepayments made in Q2 with proceeds from asset sales. Excluding these amounts, net interest expense in Q2 was $55.2 million. At the end of the second quarter, we had approximately $2.0 billion of interest rate swaps resulting in approximately 66% of our debt portfolio effectively having fixed interest rates. Q2 GAAP EPS was a loss of $6.72, driven by the nonrecurring items outlined earlier. Excluding these items, adjusted EPS was $0.44 compared to $0.71 from last year’s second quarter. With the change driven primarily by lowering adjusted operating income, higher interest expense, partially offset by the continuation – the contribution from discontinued operations. Let me provide some color on the goodwill impairment charge. Given where our equity has been trading, we performed a comprehensive review of our goodwill, which resulted in a $370.9 million noncash impairment charge in Q2 on the SUPERVALU wholesale reporting unit goodwill. This charge has no impact on the company's cash flows or debt covenants. We anticipate that additional purchase accounting adjustments in Q3 or Q4 could have an impact on goodwill. Total Q2 capital expenditures were $71.3 million or 1.16% of net sales including discontinued operations, as we continue to step up efforts to build capacity in the southeast and western regions of the country. In Q2, we reduced our total net debt by approximately $165 million, approximately $120 million of the net debt reduction was funded with cash generated from operations, net of capital expenditures and working capital performance and including approximately $70 million in net cash received from the sale of Hornbacher's and several other parcels of surplus real estate. Another driver of the net debt reduction in Q2 was a $47 million reduction in capital lease obligations due to the reclassification of approximately $31 million of built-to-suit retail property agreements to other long-term liabilities and a reduction of approximately $16 million due to purchase accounting adjustments. As a reminder, early in Q2 $566 million was used to retire the outstanding SUPERVALU bonds using the restricted cash that was set aside on the Q1 balance sheet. Q2 net debt-to-EBITDA leverage was approximately 5.0 times excluding operating leases and adjusted debt-to-EBITDAR was approximately 4.5 times. These leverage calculations are based on the two ending face value of debt, less cash on hand and the midpoint of updated adjusted EBITDA guidance for fiscal 2019, adjusted to include a full year contribution from SUPERVALU. At the end of Q2, we had $819 million of available liquidity through a combination of outstanding lender commitments under our ABL credit facility and balance sheet cash. This is the highest level of available liquidity in UNFI company history. Let's turn to our fiscal 2019 guidance, based on our performance to-date in the revised outlook for the remainder of the year. We continue to expect full year net sales to be in the range of $21.5 billion to $22.0 billion including the benefit of the 53rd week. Fiscal 2019 adjusted EBITDA including Cub and Shopper’s through the end of fiscal 2019 is expected to be in the range of $580 million to $610 million, which is down $62.5 million at the midpoint versus our prior guidance of $650 million to $665 million. There are three primary drivers of the lower adjusted EBITDA guidance. The largest driver is the weaker than anticipated Q2 results on our legacy SUPERVALU wholesale business combined with the updated distribution center realignment expectations that Sean referenced earlier. Together, these factors reduced our adjusted EBITDA outlook for fiscal 2019 by $35 million to $40 million. Second is our revised expectation associated with gross margin challenges on our legacy UNFI business, including softer sales to non-supernatural channel customers and decreased vendor promotion activity. This contributed to a $10 million to $15 million reduction in our adjusted EBITDA guidance. Third, UNFI elected to move on to LIFO inventory accounting for specified dry packaged products, which combined with the higher inflation assumption on the overall company inventory is expected to contribute another $10 million to $15 million of noncash expense in fiscal 2019 compared to our previous adjusted EBITDA guidance. As a reminder, under LIFO, when fiscal year-over-year inflation is expected on the year-end inventory, LIFO reserves are increased. This results in higher cost of goods relative to the FIFO inventory method but lower cash taxes by electing to move legacy UNFI onto LIFO, we expect to avoid approximately $50 million in cash taxes that would have been payable that we moved to legacy SUPERVALU off the LIFO method. Our fiscal 2019 GAAP EPS is expected to be a loss in the range of $6.50 to $6.10 per basic share. Fiscal 2019 adjusted EPS is expected to be in the range of $2 to 2.40 per diluted share. The increase in adjusted EPS guidance is driven by lower than previously forecasted depreciation and amortization, resulting from our updated work on purchase accounting and lower than previously forecasted stock-based compensation expense. Fiscal 2019 guidance for adjusted interest expense and capital expenditures remain unchanged. Adjusted interest expense is expected to be in the range of $181 million to $191 million and capital expenditures are expected to be 1.3% to 1.5% of net sales. Our forecast for onetime restructuring, acquisition and integration-related expenses for fiscal 2019 increased by $9.5 million to $172 million, due to higher than previously forecasted severance expense. As a reminder, if Shopper’s or Cub were divested prior to the end of the fiscal year, we would expect to incur additional onetime expenses. Our press release contains the reconciliation between GAAP net income and adjusted EBITDA and the supplemental slides provide a walk from the midpoint of our previous guidance for adjusted EBITDA and adjusted EPS to the midpoint of our revised guidance. Moving to taxes, we continue to expect to pay less than $20 million in cash taxes related to fiscal 2019 business operations. We did however make a $59 million tax payment in Q2 that was not related to fiscal 2019 business operations, which I'll review momentarily. Normally, we would provide an adjusted tax rate, but given the negative expected GAAP earnings and the positive adjusted earnings, we believe the adjusted tax rate is not as helpful as providing the estimated cash tax that we expect to pay. We are working on a significant and valuable tax election related to the SUPERVALU acquisition that we expect to make in the back half of fiscal 2019. These 338(g) tax elections treat the acquisition for tax purposes only as an asset purchase rather than a stock purchase. They will allow UNFI to utilize a significant portion of the $2.9 billion capital loss carryforward that SUPERVALU generated from the divestiture of Albertsons in calendar 2013. Under these elections, we will be able to step up the tax basis of the acquired assets, the fair market value, which provides UNFI with increased future depreciation and amortization deductions lowers our taxable income and reduces future tax obligations. To achieve the 338(g) benefits, we made a $59 million cash tax payment in February for our ordinary income associated with these elections. Net of that payment, we expect these elections to generate cash tax savings of an estimated $300 million over the next 15 years. The 338(g) related tax savings are expected to begin in the back half of fiscal 2019. In fiscal 2020, we are expecting net cash benefits of more than $20 million associated with these elections. Now let me turn the call back over to Steve.

Thanks Mike. Let me wrap it up by saying there's a lot of great work going on, which isn't always apparent in our quarterly results. In addition to the progress we're making on integrating these two companies and the sales wins we've achieved, we're making great progress on divesting our retail assets. You will recall, our goal is to thoughtfully and economically divest the retail banners with a focus on maximizing value, which would allow us to strategically focus solely on our wholesale business and I think we're on the path toward doing just that. I'd say that we're well down the path on selling Shopper’s and I'm confident we'll get that done in the coming months. And we continue to evaluate alternatives for Cub, which quite frankly is a great retail banner and has attracted interest. We will be thoughtful and careful as we determine the next steps for Cub stores, our associates, our franchisees and our partners. In January, we also talked about other opportunities to monetize assets and we're making good progress here too. Our DC rationalization work may result in duplicative facilities that can be monetized. We're working on our surplus real estate portfolio and evaluating various alternatives that can also improve cash flow. During the last several months, as Mike mentioned, we sold $70 million of property and assets and this continues to be a focus for us. And there very well could be other assets that could be sold and add value. I've mentioned many times that this transaction is a long-term play, and that position has not changed or undeterred and as committed as ever to the strategic rationale of this deal. As we do this work, the feedback we continually receive strongly reinforces that our long-term thesis for this business remains right on target. Must improve our results going forward, but we also know that we can make the necessary corrections to get us back on track, and I'm extremely confident and proud in our people and the plans we have to do so. With that, we're ready to take your questions.

[Operator Instructions] Your first question comes from Rupesh Parikh with Oppenheimer. Your line is open.

Good evening, and thanks for taking my questions. So maybe – I guess maybe to start off, given the weaker SUPERVALU performance and some of the UNFI challenges on gross margins, how are you guys thinking about the impact of these headwinds, I guess, on your longer term EBITDA forecast?

Yes. So Sean – hi Rupesh, it's Steve. So on the legacy UNFI and certainly let me speak for Sean, but certainly on the SUPERVALU challenges, we think that they're relatively near-term, there are some headwinds that we're facing as we integrate the SUPERVALU previously acquired UG, AG businesses into the UNFI network. I think that generally in the UNFI legacy business, we are facing some headwinds associated with just the general macro trends, store closures, some difficulty that some of our conventional retailers are having bringing consumers into the stores, but I think that those are generally cyclical and we'll work our way through them. Obviously, we haven't given any guidance for 2020 yet, but we're starting to give that some thought now. Sean?

Yes, I would just say, Rupesh that we've captured the issues related to the realignment activities that I discussed here this afternoon, as well as in January in our outlook for the remainder of our FY2019. And I'm sure that this is a topic that folks would want to understand more about. So these are complex projects. They require very thoughtful detailed plans to execute and they require frankly and they demand a very talented experienced team to execute. And having acquired the business here, really in the 1st of November, these projects were underway with the existing plan and change the resources in place and looking at what we know now, we did not anticipate kind of where we would land here in the quarter. However, what I can say is that, we have an A-team in place. We have UNFI's supply chain leaders and organization and talent in these DCs running points around a plan that frankly I think our leadership team certainly I have great confidence and have worked with this team for many, many years. And we've done a lot of stand-ups of new DCs and expansions of existing DCs, go-lives and so on and so forth. So as difficult as the quarter is and its impact on the fiscal year will come through it. These are distribution fundamentals, project base, require lot of hard work, but they're not structural.

Yes. And I would also add, because I know everybody probably has it on their mind and that is the question that we get all the time. As you know as it panned out as you thought it would. And I think generally the answer to that question is that it's more challenging than we thought it would be. The complications associated with SUPERVALU having just acquired two businesses on their own and then UNFI coming behind it and acquiring SUPERVALU in its entirety. So it didn't quite pan out as we thought it would. However, I think we would have still made the same decision. The strategic value is right on. We're committed to the process. The synergies are good. We're building out the store opportunities are phenomenal and we're starting to see those. We're bringing the companies together faster than we had originally anticipated. So I think it's really some short-term pain to get the UNFI culture embedded into the SUPERVALU network which we’ll do.

Okay, great. Thank you. I'll pass it on.

Your next question comes from John Heinbockel with Guggenheim Securities. Your line is open.

So let me start top line, so the $200 million of new business, was that all SUPERVALU? And secondly, the realignment issues, from outside it doesn't look like that's impacting top line very much customer disruption. Is that correct practice, you're throwing a lot of cost at the problem?

Yes. Hey, John, this is Sean. To answer the first part of the question, yes, this is SUPERVALU business that we're talking about in the $200 million of new. And secondarily, I would say that we did have some disruption in terms of certain customers that frankly we can't understand. I mean, they have to run a retail shop, we respect that. If we can’t execute at a high level, they have every right to go seek alternative supply. But we haven't lost any customer per se. It's just some dilution in our penetration. And again we believe – I certainly believe that this is short-term that our overall value proposition is very solid and it's improved certainly. So look at, we'll get any of leaks or losses back over a period of time.

And then I guess as a follow-up direct to the prior question, right. So obviously 2020 is going to come here at some point, but when you think about the 2022 targets top and bottom line, Steve, you generally still comfortable that you're close to that, because I guess, you'll get some of these expense overages back at some point?

Yes. I mean, I think at this point, we're pretty comfortable with those numbers.

Okay. Thank you.

Your next question comes from Vincent Sinisi with Morgan Stanley. Your line is open.

Hey, good afternoon guys. Thanks very much for taking my question. So just to kind of follow-up a bit further, just on the kind of the DC obstacles, as you are thinking about, you know to John's point, the 2022 targets. Are there any other kind of large scale projects between now and then of the same magnitude where if you do have maybe a bit more difficulty than originally expected that could of course be impactful or would you say that in the grand scheme of things what you are going through with this is just about kind of the most in-depth kind of risk that you have though that you can foresee at least?

Yes. Vincent, just remember that the vast majority of the issues that we're facing today are specifically associated with companies that SUPERVALU acquired before we bought them. So these issues they will probably going to happen no matter what. And we don't obviously see that repeating again as we look forward. Sean?

Yes. I would say that we certainly have – look at our network, part of our strategy and we've conveyed this and spent some time going through some detail around optimization of our distribution center network. So we have work ahead of us to do, no question. But these are going to be plans that we offer. With our team, we have a playbook in place, we know how to do this. And actually – I think in your script you identified number of DCs that we've opened up in the last six years or in the last nine or 10 years, we've opened up six or seven distribution centers from a greenfield and any number of expansions, and it is hard work but it requires playbook and we are good at that. It's just – this is a transitionary moment if you will where there are a lot of things going on in the acquisitions of UG/AG, the fold out of two distribution centers versus the Lancaster DC and PA. So sort of all at the same time and frankly we just acquired the business. So gaining a lay of the land, the talent, the buttons to push, it takes time. And frankly, we're disappointed in where we are today, but we remain optimistic that we know how to get this work done.

Yes. Sean is a little cash focused. Under Sean's leadership and a lot of the folks here at UNFI, we have a very tenured and extremely capable supply chain group that have been together for a long time. So as Sean mentioned, we've got a playbook, we know how to do this and we'll play out well over time.

Yes – no, and to your, guys, point, obviously, there's a lot going on. One, it's still new. So that's fair and helpful to hear the commentary. And then maybe just as a super fast follow-up whatever you can say at this point, it was interesting to hear kind of this quarter you're kind of taken a new approach or deeper look at kind of individual customer profitability. I guess, kind of how you see that like kind of give us maybe if you can or whatever you can kind of how are you attacking that, is this going to be something that a lot at once or spread out over time? Is there are a lot of opportunity that you think and maybe any initial kind of conversations or negotiations that you have had how they gone, that would be great.

Yes. I really don't want to go too far with that, Vincent. However, I would say that one of the things that was really important for me over the last 120 days is to really get a chance to learn and understand this business. And so I've been at it for a lot of years and we're getting into the details here. These last four months has inspired me that we have opportunities. And the best place to go with an opportunity that we're discussing around customer profitability is to sell more to that customer, drive the economics, they're important around delivery size, scale, et cetera. That's why we did this deal. And so when you pair that with some of the opportunities frankly that we're seeing here in the near-term, it actually plays very well what I think we can get done.

Okay, all right. Best of luck, guys. Thank you.

Thank you.

Thank you.

Your next question comes from Karen Short with Barclays. Your line is open.

Hi, thanks. I guess a couple of questions. One is, I mean, obviously I totally appreciate that this is a very difficult integration, but I'm just wondering – and with respect to your due diligence process, what did you think – what did you miss I guess with respect to how difficult the UNFI and associated integration was? I mean, any color there, because obviously there's a lot of risk to the entire integration, so any help that you could give us to comfort us that you're not going to have other blips going forward would be helpful.

Yes, let me take a crack, Steve, and I'll turn it over to you. Karen, I would say that, again what we're talking about here has a lot of unique complexities that we don't anticipate become sort of the road map of what's ahead. SUPERVALU just acquired Unified Grocers, just acquired AG. There' a lot going on they – at the same time they're folding out a distribution center in Lancaster, PA into two DCs, not one for one. So that came with a lot of complexity and frankly, at the end of the day that just requires a tremendous amount of talent to execute that. And so could we have understood the dynamics and diligence? Yes, I mean, you can always look back over your shoulder and say we could have done this, so we could have done that and we should have done a better job, et cetera, et cetera, but that's not for today. Today we are looking at what we've learned and how that informs going forward and making the appropriate changes to both the plans, playbook and the talent and we've done all those things.

Okay, that's helpful. And I guess looking at the distribution space in general, obviously you're looking to, I'm talking more about conventional than natural and organic, but it applies to both. I mean you're obviously looking to gain share in both segments, but your competitors are as well. So I guess the question I have is, it feels like the competitive landscape is taking – potentially taking a meaningful step up as you and your number one competitor and potentially number three get more aggressive. So, I guess, how do we get comfortable that this is kind of a race to the bottom in terms of the margins?

Yeah. Karen, what I would tell you is that there is nobody in the U.S. or Canada that had anywhere near the infrastructure, scale, the DCs that are closest to the consumer, the services, when I say services to payroll, coupon redemption, financial services and a whole slew of other things, the breadth of line, the supply chain and a whole host of other things that quite frankly would take decades or any one of our competitor, whether it'd be number one, number three or number 10 to replicate. And so our challenge in the near term is to use sales force that is rapidly coming together to make sure that we're selling the conventional non-foods to the natural and now we're selling the natural to the conventional and using the platform for meat and produce and all the things that truly built out our store to every single customer we have. And so that way we become less reliant on the overall growth rate of the industry and all about taking share and I'm really confident that we will do that well.

Okay, that's helpful. And sorry, just two housekeeping. Is the DNA that you just reported in this quarter, is that the right run rate to use? And then on your EBITDA guidance, is that LIFO or FIFO EBITDA guidance?

Yeah. Karen, this is Mike. So first of all on the depreciation and amortization, barring any additional changes in Q3 and Q4 to purchase accounting, this would be a good run rate to use. And then the adjusted EBITDA guidance that we provided is a LIFO-based number.

Okay. Thank you.

Your next question comes from Edward Kelly with Wells Fargo. Your line is open.

Hey guys, this is actually Anthony Bonadio on for Ed. Thanks for taking my question. So just quickly on your exclusive brands. I know you guys touched on the build-out in your opening remarks and at the Analyst Day. Can you just give us a quick update on your efforts here and any potential upside you could see from a margin perspective? And then any color you might be able to give in terms of what you're seeing around growth would be helpful as well. Thanks.

On the exclusive brands, I wouldn't provide any color around the margin. Obviously, our margin is deeper on our exclusive brands than it is typically on our other products. And right now as I mentioned in my script, exclusive brands like Wild Harvest, which was on legacy SUPERVALU, Field Day, which was on legacy UNFI, Everyday Essentials and a whole host of other brands are making a real difference for us. We do over 1.5 billion a year in private brands. So it's a place that we have a lot of scale and a great deal of capacity on both legacy UNFI and SUPERVALU to make a real difference for retailers. I think the second question you said was about growth, what was the question?

Yes, just how it's trending within that segment?

You're talking about private brands growth?

Yes, exactly.

I might just interject that what we've seen in the short period of time here now a few months is that, private brands in some respects is a bit of the tip of the spear as it relates to cross selling. We're already moving SUPERVALU legacy private brands into our UNFI customer base, and as Steve mentioned Field Day at other Blue Marble Brands, UNFI legacy brands into conventional SUPERVALU legacy retails including Cup, Foods, for one, so we're well on our way and private brands is actually leading us.

And one other thing I would add is legacy UNFI retail services, which is essentially using all of the expertise around UNFI natural specialty better-for-you products and applying that discipline to the legacy SUPERVALU conventional retailer so that they have the right products at shelf in the right geography will drive a lot of our cross-selling, and that's just pure data based selling on behalf of our retail sales force.

That's helpful. Thanks guys.

Your next question comes from Kelly Bania with BMO Capital. Your line is open.

Hi, thanks for taking the questions. Also wanted to ask a couple on gross margin. I guess excluding the mix shift just from adding SUPERVALU into the mix and the vendor promotion and the issues that SUPERVALU that you called out. Wondering if you can just isolate kind of what you guys see as the core gross margin mix shift degradation if there is any for the quarter?

It's just primarily driven by our fastest growing customer is our lowest margin customer.

Yes. So can you quantify that?

I don't think we can call that out.

Okay. And in terms of your guidance for this year and longer term, was there a change to your D&A guidance in – as part of your adjusted EBITDA guidance for this year and as we think about the 470 million you provided in January for fiscal 2022, is that still the right number?

Yes. So adjusted EBITDA obviously does not include depreciation or amortization expense. So the updated guidance that we provided, you see the impact of the reduction to depreciation, amortization as you look at the EPS line for GAAP or adjusted EPS, but it wouldn't have impacted adjusted EBITDA dollars.

Okay. And just maybe another on the vendor promotional activity. Can you help us understand what's driving that? Is that something you also see as a near-term issue which areas of the business is that impacting and what you're expecting on that front going forward?

Yeah. Hey Kelly, this is Chris. Yes, that's primarily on the UNFI legacy business and it just, primarily we believe as part of the macro environment as more and more suppliers are holding their price, watching promotional funds, reducing promotional funds, being more margin conscious. I do think it is temporary, and there are methods that we have in place to mitigate it and improve that trend. So, we do believe it is short-term based.

Yes. And the other thing Kelly is, if you look at our historical supplier out of stocks on the UNFI legacy side, they're still at all time highs. And so if the benefit, the suppliers can give us the product, then obviously they're going to have a great difficulty promoting it.

Right. And then maybe Steve, just a last follow-up for you. You mentioned some issues at conventional retailers maybe just driving traffic to the stores. I just haven't heard that called out. Maybe you can just help us understand what you're hearing from your customers there and if there's anything you can do to help them with that?

Yes. I mean it's a general comment that if you look down on our customer list of conventional retailers, some of them are having difficulty bringing consumers into the store and having impact in their year-over-year index. And again it's not true across the entire customer mix, but certainly if you look at our performance in the quarter, it's the first time in a long time that that channel was actually negative versus prior year. Now I think that is cyclical, it's a short-term headwind, that will turn itself around, but the comment was specific to this particular quarter and some of the conventional retailers within that channel.

Chantal, I think we'll take one more question before Steve add some concluding remarks.

Your next question comes from Andrew Wolf with Loop Capital Markets. Your line is open.

Great, thank you. So Sean, I think you said the costs in the distribution realignment and so forth were non-structural. So just help us understand that? Could you give a couple of examples like some of them are, like when I think of non-structural cost with realignment, it's like, hey, we're moving inventory from the old DC to the new DC and once that labor is done it goes away. Are those what you're talking about or is it something more kind of complex and harder to explain?

No Andy, actually the basic tenants that you just described is what we're talking about. So the extraordinary costs associated with hiring labor, training labor, the productivity sort of lead if you will around getting folks, getting the team up to speed on our productivity, that's a drain in terms of cost, inventory moves, et cetera, et cetera. So there are five or six key buckets that are over a period of time normalize out. So structural meaning that it doesn't become an ongoing issue. So, I think we're on the same page.

Okay. And the other thing is, do these DCs have enough volume that as the metrics improve they'll normalize to the right profitability or are they I guess if you’re consolidating or they actually net greater volume greater productivity. Could you just speak to that a bit?

Yes, sure. I mean, keep in mind, when we're talking about the Pacific Northwest, which we spent some time illustrating in January, we're actually moving from five distribution centers into two. And so we are not deleveraging in that environment. We have an approximate demand relationships to the capacity, we're adding automation, it's a net win, it's a net positive, lowering both P&L expenses and there is some positive balance sheet action as a result of it. And so in Lancaster PA and in other distribution centers that we take the appropriate actions to optimize, we'll be doing so based upon driving a return. So, it will all be about as it always is about getting the right returns. There is aggravation in the short term around all these projects as one-time issues that we described, but we normalize, we get there, we right-size.

Okay. And just one other follow-up on the same topic. Steve you characterized that or you said there was a material improvement week-by-week at these affected distribution centers. So, I don't know when it peaked in the second quarter. But if that's going to continue, that means by the fourth quarter you're going to have somewhere between the second and third quarters the peak expense hit and then the fourth quarter will be lower. Am I thinking right about that?

Well, we sequentially improve the results from the DCs throughout the second quarter. We expect that to continue throughout the balance to the year, that's all involved in the revised guidance that we have given.

Okay. So the third quarter will have less impact in the floor. Okay, that's good to hear. And I guess would be last follow-up. And I am done then. It was good to hear you're getting some new business. What are your expectations there? Do you think that – I mean, do you have a pipeline of folks or do you have to concentrate on the issues you had this quarter before you can really aggressively pursue new business?

Hey Andy, it's Chris. The short answer to that second question is no. We are aggressively pursuing new business, in fact, receiving inbound inquiries on new business, which is exciting. The pipeline is robust, ranging everything from an incremental sale, professional services to very, very large nine digit opportunities, which of course will take longer to print. There is no timeline on it in the sense of when they come, just the larger ones take a long time, the smaller ones are starting to see them now.

Okay. And Chris, your comments is for the whole enterprise not just for the UNFI side of the business, right?

Correct.

Okay, thank you.

Thank you again for joining us tonight. We are on a long-term mission to transform the way food is procure and delivered. Our strategy is sound, despite some short-term integration and network optimization hurdles. UNFI will emerge as the most sophisticated and scale provider of solutions, services and products in U.S. and Canada. Our heritage of excellence in better-for-you foods, paired with our fully built out store offerings and supply chain will move us forward over time. Thanks again for joining us and have a good evening.

This concludes today's conference call. You may now disconnect.